[2009] UKFTT 382 (TC)

TC00317

Appeal number SC/3066/2009

LOSS RELIEF — shares of negligible value — TCGA 1992 s 24(2), ICTA s 574 — whether shares “became” of negligible value — value of shares at dates of allotment — values found to be negligible at those dates — relief not available — appeal dismissed

First-tier tribunal

tax

DAVID HARPER

Appellant

– and –

THE COMMISSIONERS FOR HER MAJESTY’S

REVENUE AND CUSTOMS

Respondents

                   Tribunal :  Judge Colin Bishopp

                                      Robert Barraclough

Sitting in public in Manchester on 21 October 2009

Howard Wadsworth, chartered accountant, for the Appellant

Kathryn Doyle of their Appeals Unit for the Respondents

© CROWN COPYRIGHT 2009

Decision

1.           This is an appeal against the Commissioners’ refusal to allow to the taxpayer, David Harper, a claim for loss relief made by him in his return for the year 2003-04. The claim was made in accordance with s 574 of the Income and Corporation Taxes Act 1988 and s 24(2) of the Taxation of Capital Gains Act 1992. The latter provision, at the relevant time, provided that

“Where the owner of an asset which has become of negligible value makes a claim to that effect:

(a)      this Act shall apply as if the claimant had sold, and immediately reacquired, the asset at the time of the claim …”.

2.            That provision enables the owner to crystallise his loss. Section 574 of the 1988 Act (now repealed and replaced but in force at the material time) provided that a taxpayer who had suffered a loss on the disposal of shares in a qualifying trading company which was allowable for capital gains tax purposes, including one crystallised by the application of s 24 of the 1992 Act, might set that loss off against his income tax liability. There is no dispute that those provisions are, in principle, available to the taxpayer in this case.

3.           The parties are agreed too that the relevant asset, shares in a qualifying trading company called HMS President (1918) Limited (“the company”), were of negligible value at the date of the claim, 5 April 2004. What is not agreed is their value when the taxpayer acquired them, in June 2002 and December 2003. He claims that they were worth at least what he paid for them, their par value amounting, in respect of the June 2002 allotment, to £149,890 and, in respect of the December 2003 allotment, to £250,000. The respondents say they were of negligible value then, that accordingly they did not thereafter “become” of negligible value, as the statutory provision requires, that in consequence no allowable loss has been suffered and that the relief claimed is not available.

4.           The respondents also advanced the argument that the taxpayer had not in fact subscribed for any shares on either occasion, but there was clear evidence, in the form of their own notes of meetings, that they had led the taxpayer to believe that the only issue in the appeal was valuation, and had raised (or perhaps revived) this argument only shortly before the hearing. We refused to allow the respondents to advance the argument in those circumstances and the only question for our determination, therefore, is the value of the shares in June 2002 and December 2003.

5.           We take the following facts from the evidence we heard and the available documentation. For the most part the background was undisputed; we identify those few matters of fact which were either disputed or not admitted, but little turns on them.

6.           The taxpayer is a farmer and property developer, occupations in which he has been engaged since 1978. In 2000 he identified a possible venture similar to property development, the acquisition of a ship, HMS President, which was and is permanently moored on the River Thames near to Blackfriars Bridge. The ship was used by its then owners, a charity, as an entertainment venue for corporate hospitality and private entertaining. Parts of the vessel were let to commercial organisations which provided various facilities to their customers or used the space as offices, and further parts to other charitable organisations. The remainder was retained by the charity for its own, predominantly commercial, use, a use which appeared to the taxpayer to be very profitable. He ascertained that the charity was interested in disposing of the ship and entered into successful negotiations for its purchase.

7.           The acquisition was made by the company which was incorporated, for the purpose of purchasing and thereafter exploiting the ship, on 12 January 2001. An initial issue of 1,000 shares was made, of which 610 were subscribed for by, and allotted to, the taxpayer. The remainder were allotted to members of his family and friends. The ship, the goodwill of the existing business and some miscellaneous minor assets were acquired on 27 April 2001 for the aggregate price of £980,000. However, that was not the full extent of the company’s liability. The agreement for sale required it in addition to pay deferred consideration in the shape of a donation to the charity of £500,000, to take on three members of the charity’s administrative staff (with responsibility for the future payment of their salaries), to pay a consultancy fee to one of the charity’s trustees, to honour various agreements, including but not limited to the subsisting licences granted to the various occupants of the vessel, and, perhaps most importantly of all, to carry out extensive refurbishment and repair of the ship, a requirement which necessitated its being taken to dry dock. The estimated cost of the repair and refurbishment was in the order of £500,000. The taxpayer entered into a personal guarantee of the company’s obligations.

8.           The acquisition was funded in part by the capital subscribed by the shareholders, in part by funds injected by the taxpayer and reflected in his director’s loan account (so we were told—we did not see full accounts, and, significantly, were provided with no balance sheets) and in part by a mortgage on the ship of £1,050,000, advanced by Lombard North Central plc. Lombard relied (one must assume) on a valuation of the ship and the business which it obtained, before the money was advanced, placing the value of the ship and the business at £2,650,000 or, on a forced sale following failure of the business activity, at £1,600,000.

9.           The company began trading immediately—it took over the charity’s commercial activities as a going concern—but trade was suspended in July when the ship was removed from its moorings and towed downstream with a view to its being taken to dry dock. The taxpayer told us that some of the refurbishment work had been completed by that time. The ship was built in 1918 as a Royal Navy corvette and was decommissioned and moored at its present location in about 1930. Its engines were removed and it is, consequently, dependent on tugs for its movement. Trials showed that the ship would not survive being towed to Hull, where the nearest dry dock of sufficient size to accommodate it was located, and the exercise was accordingly aborted. Eventually, but not until a dispute with the Port of London Authority (which was initially insistent that, despite its unseaworthy condition, the vessel be taken to dry dock) was resolved, the ship was returned to its mooring, arriving in September 2001. Unfortunately its removal had led to water ingress, causing damage to the ship and to some of the refurbishment work already carried out.

10.        The aborted exercise had, of course, cost the company a considerable sum of money, and it had been unable to trade during the period when the ship was away from its mooring, and while the damage it had sustained was put right. We were not provided with fully documented figures, but it was clear that the cost to the company was substantial. The taxpayer estimated the total loss of cash flow at £500,000. Repairs were later effected without the use of a dry dock, the Port of London Authority having by then relented, though it did not become clear to us whether they were as extensive as had originally been planned. We had a good deal of evidence, some of it historic, about the cost or projected cost of repairs and refurbishment, but very little evidence of what was actually done, and when.

11.        The company’s intention had been to pay for the dry docking and refurbishment with further money, £500,000, to be borrowed from a bank. Although, the taxpayer said, a loan had been agreed in advance in principle the offer was withdrawn on the very day contracts for the purchase of the ship and the business were exchanged.

12.        Not surprisingly these events caused great financial difficulty to the company. The taxpayer injected further money, raised by mortgaging other properties he owned, in return for which, he said, the June 2002 allotment was made to him. His cash injections only partially relieved the problem, and by September 2002 the company had fallen into arrears in its payments to Lombard. The company commissioned a further valuation, from the same firm which had advised Lombard before the mortgage was advanced. The report, dated September 2002, valued the ship and the business, as a going concern, at £2,750,000. No forced sale valuation was offered. The report records the recent repair and refurbishment, while pointing out that it was apparent that yet further work was required. The valuers did not carry out a structural survey, but said that they relied on the company’s assurance that the vessel was in repair. They also relied on the company’s statements about the profitability of its trading activities, and made no investigation of their own.

13.        The taxpayer’s evidence was that he and Lombard, to which the report was disclosed, were reassured by the valuation. Lombard did not immediately call in its loan, and the taxpayer subscribed for a further 250,000 shares, at £1 each. For reasons which were not explained (in fact, the taxpayer’s evidence about the topic did not match the surrounding documentation) the allotment was not made until December 2003. By late 2003 or early 2004 the company had fallen into further arrears in its mortgage payments and Lombard was actively seeking to realise its security by accepting an offer for the company’s assets of £850,000, a sum which would not have covered the full indebtedness. In the event, the sale did not proceed. Lombard began proceedings to enforce the personal guarantee the taxpayer had given, evidently taking the view that the company would not be able to pay and that sale of the ship could not be expected in the near future, the intended sale having fallen through. The company also failed to make all of the necessary payments to the former owners and litigation ensued; it was compromised when the taxpayer made a payment, substantially less than the total amount owed.

14.        The company continued to trade but by June 2004 its financial position was so poor that, when a winding-up petition was presented by a creditor, it was compelled to enter into administration. The administrator continued the company’s business, and made small operating profits, but disposed of the ship, the goodwill and the assets in April 2006 for the aggregate sum of £250,000. The company thereafter went into liquidation, with a net deficiency even for secured creditors.

15.        The taxpayer concedes that the company had substantial debts, and that its net asset value at June 2002 and December 2003 was less than the gross value of the ship and the business, but argues that at both dates it nevertheless had a significant, positive value and that the value of the shares when he subscribed for them was in excess of their nominal value of £1 each. The respondents’ position, in essence, is that by June 2002 the net asset value of the company was nil, and that it did not improve thereafter; consequently the shares for which the taxpayer subscribed then and in December 2003 were already of negligible value. Alternatively, they say, the taxpayer has not established that they had a value. They concede that the shares for which the taxpayer subscribed on formation of the company, that is 610 £1 shares, were then worth their nominal value, and his claim for loss relief has been admitted to the extent of £610.

16.        We begin with a brief analysis of the meaning of “negligible value”, brief because although the taxpayer’s accountant, Howard Wadsworth, who represented him at the hearing raised the topic, it does not seem to us to be a source of disagreement. The 1992 Act does not define the expression, and neither party referred us to any judicial authority on the point. The respondents’ internal guidance suggests that “negligible value” means “worth next to nothing”. Mr Wadsworth did not advance an alternative meaning. It seems to us a fair interpretation of the legislation, and it is one we shall adopt.

17.        Mr Wadsworth’s starting point was the valuation provisions of ss 272 and 273 of the 1992 Act which, again, do not seem to be controversial. Together, and as interpreted by Plowman J in re Lynall (1971) 47 TC 375, they provide that shares in an unquoted company (as the company was) are to be valued upon the basis of their open market value, meaning the price which would be agreed between a hypothetical willing seller and a hypothetical willing purchaser in possession of all the information a prudent prospective purchaser would reasonably require, and upon the footing that neither party has a special interest.

18.        His argument was that when the company bought the business, including the ship, it was functioning successfully and profitably. Its principal asset, the ship itself, was moored in an attractive prime location, and had the benefit of a liquor licence, commercial kitchen facilities and the income from the various licences or leases which were in place. It was plainly a valuable asset, even regardless of the company’s business activities. In the interval between the company’s entering into administration and the sale of the business the administrator had run it profitably, and the current owners of the ship were also running it profitably (we are willing to accept for present purposes that they are, but we had no evidence on the topic—all the taxpayer was able to tell us was that he had in turn been told they had achieved an annual turnover in excess of £1 million). The company failed not because of a want of assets, but because of cash flow difficulties. The net asset value of the company in June 2002, he said, was £1,539,000, and in December 2003 it was £1,420,000. Mr Wadsworth did not back up those assertions with calculations. He preferred, he said, the more usual earnings basis; if that were adopted the company’s value would be higher still at both dates. In either case the shares were worth more than their par value when the taxpayer subscribed for them.

19.        The pre-purchase valuation report recites that the previous owners had made net operating profits in 1997 of £114,000, in 1998 of £180,000, in 1999 of £315,000 and in 2000 of £342,000. We had no further evidence of those figures, but have no reason to doubt their accuracy. The figures showed, Mr Wadsworth argued, that the business was indeed very profitable. The company had not made profits during the period it was trading, but that was because it had to discharge non-recurring expenses, which the previous owners had not. Mr Wadsworth—who both represented the taxpayer and gave evidence—had made a calculation, starting from the company’s turnover as revealed by its VAT returns. By assuming that its gross profit would bear the same relation to turnover as had been the case when the business was run by its former owners, by eliminating the non-recurring expenses and by making some other adjustments he was able to show that the company could expect to make a post-tax profit of about £57,000. He then applied a price : earnings ratio of 7.96 (discounted from the industry norm as this was a small private company) to arrive at a value of all the shares of about £454,000 in June 2002. We were invited to accept that their value would be at least as much in December 2003.

20.        We also had the evidence of Frederick Cook, an assistant director of the Commissioners’ Shares and Assets Valuation division. He is not, of course, an independent valuer, but nor is Mr Wadsworth. Mr Cook had dealt in his previously disclosed evidence only with the value of the shares in December 2003, believing when he prepared that evidence that there had been no allotment to the taxpayer in June 2002. As we have indicated, we have proceeded upon the basis that there was indeed such an allotment. Mr Cook did, however, give oral evidence about the shares’ value at that time.

21.        His main point in relation to the June 2002 value was that Mr Wadsworth’s figures were based on very little evidence. We interpose at this point that the absence of evidence was conspicuous. The company had not produced any annual accounts during its pre-administration lifetime of three years (for reasons we did not discover) and it was impossible to be confident, from the two sets of unaudited management accounts we had, what its financial performance had been. We had no balance sheets, or any evidence which might substitute for them. Much of the taxpayer’s evidence was chronologically inaccurate, as was apparent from a comparison of what he said with the available documentation, and there were other inaccuracies in what he told us, though we are sure the inaccuracies are attributable to nothing more than poor recollection.

22.        It was pertinent, Mr Cook said, that the pre-purchase valuation noted that the net operating profit figures it set out took no account of depreciation, finance charges and directors’ remuneration. All of those were costs which the company would have to bear. Mr Wadsworth’s approach was in part based on an assertion that the company could change its borrowing arrangements to reduce the interest costs; that, Mr Cook considered, was an unrealistic aspiration for a company which was already in some financial difficulty and was making losses, whatever the reason for its losses might be.

23.        It was, Mr Cook added, impossible to determine, from the information set out in the limited management accounts which had been produced, that the company could become profitable. The first of those accounts, for the period 1 April 2001 (in fact the period must have begun on 27 April 2001) to 31 March 2002, showed a loss of almost £154,000, and the second, covering the company’s trade from (again) 1 April 2001 to 30 June 2002, showed a net loss of almost £230,000. Even those figures appeared to make no allowance for directors’ remuneration. The company had lost a good deal of money in connection with the abortive dry docking, yet it had continuing repair and maintenance obligations and it also still had large sums to pay to the former owners. It was, he said, wholly unrealistic to base a valuation on what could only be described as the potential profit if all went well when the reality was that the company was making losses and was already in considerable financial difficulty. He was very doubtful whether in June 2002 the company’s assets were sufficient to cover its liabilities, and was confident that the shares, if offered, would not have found a buyer, with the consequence that they were effectively valueless.

24.        He was very critical of Mr Wadsworth’s approach, which he said relied too much on assumption and was excessively generous in its writing back of supposedly non-recurring expenditure. If one took Mr Wadsworth’s estimation of gross profit but then deducted a more realistic amount of expenses, it was possible to achieve a small annual operating profit of about £7,000, but that figure would be comfortably exceeded by non-operating expenditure, particularly the cost of the outstanding refurbishment and the liability to the former owners. The small operating profit made by the administrator had, likewise, been exceeded by administrative costs. Mr Cook pointed also to several documents, including letters from Mr Wadsworth, which indicated that the company was insolvent as early as January 2002, and that it was frequently unable to pay its debts as they fell due.

25.        By December 2003 the company’s position was, Mr Cook said, even worse. Little reliance could be placed on the September 2002 valuation; not only was it by then over a year old, but it was based not on an independent appraisal of the ship and the company’s business, but on no more than a visual inspection of the ship and on the company’s own estimation of the profitability of its business.

26.        The burden of showing that he is entitled to the relief he claims lies on the taxpayer. In many cases it would be possible to assume without more that shares for which a person subscribed were worth approximately the sum paid for them, but this is not such a case: it is in our view apparent that a much more critical look at the company’s value is necessary. The evidence we heard, as we have indicated, was surprisingly lacking in some respects, but we can make some findings with confidence. In doing so, we prefer Mr Cook’s evidence to that of Mr Wadsworth; we share Mr Cook’s view that Mr Wadsworth’s calculations are based more on hope than experience.

27.        It is clear that the company had a very bad start, when its additional borrowing failed to materialise and the abortive dry docking resulted in the waste of a very large sum of money. The management accounts produced show that from the outset the company was making substantial losses, and a comparison of  the two sets, even though one must be cautious of such a comparison, suggests that the position was worsening: a loss of £154,000 in the company’s first 12 months had increased to £230,000 by the end of the first 15 months. By the summer of 2002 it was struggling, if not more, to keep up with its mortgage payments, and we were left in little doubt that the money injected by the taxpayer in June 2002 was not made by way of investment in a thriving company, but in order to keep the company afloat. We agree with Mr Cook that Mr Wadsworth’s projections of its future profitability are unrealistic; we are satisfied that this was, by June 2002, a company in considerable financial difficulty.

28.        By early 2004, as is obvious from the facts as we have set them out, the company’s position was worse still; it had defaulted on its mortgage payments and on the payments still due to the former owners, and its shareholders’ personal guarantees were being called upon. The information we saw which was provided by the administrator and, later, liquidator suggests that the company was hopelessly insolvent when it entered into administration. We had no evidence at all about its turnover or profitability (or, one must assume, the scale of its losses) in December 2003. Against that background it is impossible to conclude that the company was solvent and that its shares had any value at that time. It seems to us much more likely than not that the company was on the brink of collapse and that the taxpayer’s injection of cash in return for which more shares were allotted to him was made, on this occasion as in June 2002, in an ultimately unsuccessful attempt to save the company and escape the prospect that the creditors would call on his personal guarantees.

29.        In short, the taxpayer has not shown that in June 2002 and, separately, in December 2003 the shares for which he subscribed had any value, whether one examines the company’s net asset value or its value as a going concern. There is no reliable evidence from which we could properly conclude that the company had a positive value, reflected in its shares, at either of those dates, still less evidence from which we might come to a conclusion about what that value might have been. We have accordingly concluded that the shares did not “become” of negligible value because they were always of negligible value, and the relief claimed is not available. The appeal is, therefore, dismissed.

Colin Bishopp

Tribunal Judge

Date of release: 29 December 2009